The economy of Pakistan, like other developing
economies, is characterized by capital deficiency, a narrow industrial
base, low capital-labour ratio, large disguised unemployment, lack of
technical and managerial skills, a culture of inefficiency and
overwhelming reliance on export of primary goods. Foreign investment,
particularly, foreign direct investment (FDI), can be an important
instrument of overcoming these structural weaknesses necessary for
transition towards development.

The role of foreign investment as an impetus to
economic development depends in the main on two factors: the magnitude
or level of investment and the direction of investment. Since the
purpose of attracting foreign capital is to supplement the domestic
resources, the level of foreign investment must be such that it fills
the gap between domestic savings and the desired level of investment.
The gap in case of developing economies is rather high. In case of
Pakistan, for example, domestic savings constitute only 15-18 per cent
of GDP.

In order to increase the level of foreign capital
inflows, developing countries liberalise their trade and investment
regime by relaxing governmental controls and offering a number of
financial and trade incentives like tax concessions and tariff
reductions. Though exceedingly important, the right level of foreign
investment is not enough.

What also matters is the direction of investment,
that is, in which sectors it is made. For this purpose, the host country
has to pursue active liberalization policies. For instance, to overcome
trade deficit, the host country may encourage greater investment in
export-oriented sectors or require foreign enterprises to export a
particular percentage of their locally made goods. To increase
employment generation, special packages may be announced for investment
in labour intensive industries. To ensure that FDI stimulates domestic
economic activity, the host government may make it mandatory for the
foreign investor to use a certain amount of locally made inputs in
production of final goods. This is called local content requirement. For
up-gradation of technical and managerial know-how, the recipient country
may require the foreign enterprise to transfer technology to domestic
industry or to employ a particular proportion of local talent in
managerial and technical positions. To broaden the domestic industrial
base and give a momentum to industrialisation, investment in only those
sectors may be opened to foreigners which are vital to the development
of other sectors.

One problem with such measures, however, is that they
may become an impediment to FDI inflows. Secondly, under the Agreement
on Trade Related Investment Measures (TRIMs) of the WTO, many of such
measures are disallowed. A third problem is that when countries conclude
international investment agreements, they insist that their enterprises
investing abroad should be given greater freedom in terms of choice of
industries and production and marketing operations.

Let's have a glance now at the level and direction of
FDI in Pakistan. From 1992-2003, total FDI in Pakistan has been worth
$6.4 billion. This makes average investment per year nearly $550
million. The volume of investment was highest during 1995-96, when FDI
crossed $1 billion. The surge in investment was mainly due to agreements
signed with independent power producers (IPPS). However, subsequently
FDI registered a fall. It touched the low water mark in 2000-01 when it
was only worth $322 million. The main reasons for the fall in investment
were the discontinuity and unpredictability of policies particularly the
government's row with the IPPs, Pakistan's decision to go nuclear and
the subsequent restrictions which that decision invited, and the Kargil
conflict with India. However, in 2001-2002, there was an increase in FDI
as it touched $485 billion. During the last financial year, FDI further
rose to $798 million. In the first eight months of the current fiscal
year, FDI receipts stand at $385 million registering a fall by 39 per
cent over the last fiscal year's corresponding period.

Interestingly, while global FDI inflows registered a
fall in 2002 from $735 billion in 2001 to $651 billion, FDI in Pakistan
and South Asia rose. In South Asia, FDI rose from $4.07 billion in 2001
to $4.5 billion in 2002. In 2001, India accounted for 83 per cent of FDI
inflows into South Asia, however, in 2002 its share dropped to 76 per
cent. In contrast, the share of Pakistan in South Asian FDI receipts
almost doubled from 9.46 per cent in 2001 to 18 per cent in 2002.

As for the direction of investment, during last one
decade, the largest amount of FDI has been made in the energy sector,
which accounts for more than 42 per cent of total FDI. The share of
manufacturing has been about 25 per cent followed by the services sector
whose share is 21 per cent. During 2002-2003, however, the banking and
finance sector overtook the energy sector as the largest FDI sector. It
attracted investment worth $207 million — 25 per cent of total
investment.

Having glanced at the level and direction of FDI in
Pakistan, let's look at the country's foreign investment regime, which
consists of three components: regulatory, economic and socio-political.
Courtesy privatization and deregulation, Pakistan has a very liberal
regulatory regime. The regulatory framework for foreign investment
consists of three laws: Foreign Private Investment (Promotion &
Protection) Act 1976; Furtherance and Protection of Economic Reforms Act
1992; and Foreign Currency Accounts (Protection) Ordinance 2001. Owing
to increasing emphasis on the protection of intellectual property rights
(IPRs), Pakistan has also updated its IPR laws to bring them in
compliance with international requirements particularly those mandatory
under the Agreement on Trade Related Intellectual Property Rights (TRIPs)
of the WTO.

The salient features of Pakistan's regulatory regime
are:

•There is freedom to bring, hold and take out
foreign currency from Pakistan in any form.
•Fiscal incentives provided by the government cannot be altered to the
disadvantage of the investor.
•The privatization of an enterprise is fully protected. It cannot be
re-nationalised. Nor can the government take over any foreign
enterprise.
•Original foreign investment as well as profits earned on it can be
repatriated to the country of origin.
•Equal treatment is provided to a foreign investor and local investor
in terms of import and export of goods. FDI is not subject to taxes in
addition to those levied on domestic investment.
•Foreign currency accounts are fully protected and they cannot be
freezed (courtesy the Foreign Currency Accounts Ordinance 2001).

As regards to investment policy, all economic sectors
including the service sector are open to FDI. Foreign equity up to 100
per cent is allowed in all sectors save the agriculture sector where it
is allowed up to 80 per cent. In manufacturing sector, there is no lower
limit on the size of FDI. In services and other sectors it is $0.3
million. No government sanction is required for setting up an industry
in terms of field of activity, location and size except in case of four
sectors. To avoid double taxation on income earned by foreign investors,
Pakistan has concluded agreements with 51 countries. The list includes
most of the developed countries. Pakistan has also bilateral investment
protection agreements with more than 40 countries.

Pakistan has also rationalized its tariff regime.
Custom duty on import of most of the primary raw material is not more
than 5 per cent, while that on imported machinery is between 0 and 10
per cent.

As for the IPRs framework, copyright law has been
amended while laws regarding patents, industrial designs and trademarks
have been re-enacted. The purpose of fresh legislation is to broaden the
scope of IPRs, particularly to protect the works of foreign authors
inventors and firms in the same manner in which the works of local
authors or firms are protected.

Though IPR laws have been updated, their enforcement
needs a lot to be desired.

This is particularly true in case of copyright
enforcement as piracy, especially that of software, is rampant in the
country.

Pakistan's economic indicators have also improved.
Growth rate is 5-6 per cent. Rupee is stabilized and inflation is less
than 4 per cent. Banking system has been revamped, interest rates have
been cut and the level of liquidity improved. The working of the capital
market has also vastly improved. Add to this Pakistan's improved
relations with the USA in particular and the western world in general.
This is important because an overwhelming majority of MNCs in the world
are either American or European firms. In Pakistan itself, out of the
300 major foreign enterprises having their production facilities 145 are
European and 70 American.

This is a rosy picture. But all is not rosy in
Pakistan. The investment climate has its thorny side. Take political
uncertainty first. Political instability has been endemic in Pakistan.
During 1990s four governments and parliaments were dismissed and three
general elections held. Towards the close of the decade, the civilian
set-up was replaced with a military regime. Frequent changes in
government have made continuity and predictability of policies difficult
thus adding to the risk of doing business in Pakistan.

Law and order situation is another factor. During
last one and half decade, the twin menaces of sectarianism and ethnicism
have run rampant in Pakistan. They have told upon our economy and
presented Pakistan as an intolerant, lawless society. In many cases,
foreigners and facilities owned by foreign enterprises have been
attacked.

The third factor is lack of human capital. Wages in
Pakistan are low but productivity is also low. While making investment
decisions, MNCs take into account both worker productivity and wages.

Infrastructure, including rail, road and
telecommunication network, and price and availability of utilities is
another area that needs a lot of improvement. Cost of water and power
for business customers in Pakistan is higher than those in other
neighboring countries like India and China. Infrastructure is also not
up to the mark. Poor infrastructure and high cost of utilities increase
the cost of doing business and make the country a less attractive market
for FDI.

Last but not least is the cultural factor. An
overwhelming majority of existing or potential MNCs in Pakistan are from
the West. The people of the West have a different lifestyle from us and
want to continue that while staying here. However certain self-righteous
people want to impose their own values on foreigners and thus meddle
into their personal private lives. Nothing irks these foreign investors
and managers more than meddling into their personal lives.

In brief, Pakistan has a lot of potential to attract
foreign investment. However, there are factors like political
uncertainty, poor law and order, low labour productivity and cultural
intolerance that have, and are likely to bottleneck the growth of
foreign investment.